Wednesday’s Unusual Options Activity Fell Squarely on Carvana

Used car e-commerce platform Carvana (CVNA) has been on a wild ride the past two days after Bloomberg reported late Tuesday that a group of creditors was negotiating directly with the company on its debt. 

As a result, Wedbush Securities analyst Seth Basham downgraded its stock to underperform on the belief that any debt restructuring leading to bankruptcy would render Carvana’s shares worthless overnight.

On Wednesday, its shares fell 43%. As I write this midway through Thursday trading, CVNA stock has regained about one-third of Wednesday’s losses. 

One thing for sure is that there was unusual options activity revolving around Carvana’s stock on Wednesday. The question for investors is whether they should buy or sell the company’s call options. 

Here are my two cents on the subject. 

Carvana’s Volume/Open Interest Ratio Was Off the Charts

Regarding volume as a percentage of open interest, Carvana had two of the five highest ratios in Wednesday's trading. 

The Jan. 20/2023 $5.00 call contract had a volume of 14,092, 60.22x the open interest, making it the highest ratio amongst call options with unusual options activity yesterday. The fourth-highest ratio was the April 21/2023 $10.00 call option. It had a volume of 6,625, 25.29x the open interest.

In total, it had five of the top 100 call options with unusual options activity on Wednesday. 

Both bears were looking to cash in on the latest bad news for the beleaguered company, whose shares have lost more than 98% of their value over the past year. 

For example, the seller of the $5.00 call gets to keep the $75 premium paid by the buyer if the share price stays the same or falls in value. Not surprisingly, with today’s rebound, the ask price has doubled to $1.55, or a $155 premium. 

With 43 days to expiry, it’s entirely possible that the share price could rise above the $5.00 strike price before Jan. 20, reducing one’s profit on the premium. For example, if on expiration, the share price is $5.25, your profit will be $75 less $25, which is the difference between what you would pay for the 100 shares ($5.25) and what you sell them for ($5.00).   

So, if you were a call buyer on Wednesday, you’re up 107% on your investment ($1.55 less $0.75 dividend by $0.75). Of course, this is a very fluid situation. By the end of the day, the premium will have moved one way or the other based on the share price. 

The delta on the $5.00 call is 0.39606, which means a $1 move in the share price either way results in a 40-cent move in the premium.

Carvana is an excellent example for new options investors to buy on a simulated basis to see how they’d make out. However, with the debt restructuring situation evolving, I’m not sure you want to cut your teeth on this one. 

Is Carvana Stock Worth Owning?

Not according to Seth Basham, it’s not. The analyst has a $1 target price on Carvana. That’s 78% lower than where it’s currently trading. 

Regarding the company's debt situation, Carvana finished the third quarter with $8.07 billion in total debt against $316.0 million in cash, for net debt of $7.76 billion, nearly 11x its market cap.

Its interest expense through the first nine months was $333 million, 2.8x its interest expense a year ago. Add in $55 million from Q4 2021, and you’re up to $388 million for the trailing 12 months ended Sept. 30.

Operationally, virtually every key financial metric is way down in 2022.

For example, while its net revenues through Q3 2022 increased 18.8% to $10.77 billion, its gross profit margin was 9.8%, 580 basis points less than a year ago. Further, its gross profit per vehicle in the third quarter was $3,500, 25.1% less than in Q3 2021. 

From a profitability standpoint, whether we’re talking on a GAAP or non-GAAP basis, it’s piling up the losses. Over the past four quarters, it was $1.64 billion on a GAAP basis. On a non-GAAP adjusted EBITDA basis, it lost $815 million. 

Either way, you slice it, it’s bleeding red. 

Surprisingly, analysts haven’t completely jumped off the bandwagon just yet. Of the 21 covering Carvana stock, four rate it a Moderate or Strong Buy, with only two suggesting it’s a Strong Sell. However, a month ago, analysts rated it a Moderate Buy. My guess is it could drop to Strong Sell from Hold once more information becomes available. 

The mean target price is $25.38, according to Barchart’s analyst data. That doesn’t seem accurate, given the $1 target from Wedbush. MarketWatch has an average target price of $17.17. That, too, seems high. 

The analyst estimate for 2022 is a loss of $9.97 a share. In 2023, the loss is expected to fall to $7.03. 

The Bottom Line

CarMax (KMX) is Carvana’s much bigger competitor in the used vehicle market. Its market cap is 14x Carvana’s. Yet, its net debt is $3.57 billion, or 35% of its market cap. Its interest expense through the first half of 2022 was $61.5 million, considerably less than Carvana’s.

And, while its profits are nearly halved from a year ago, it still generates a GAAP profit. In these times of uncertainty, that’s a meaningful difference. 

According to GuruFocus.com, Carvana has an Altman Z-Score of 1.25. 

The Altman Z-Score takes into consideration key financial metrics to determine the likelihood of entering bankruptcy protection within the next 24 months. Anything below 1.81 indicates that the business is in distress. As new information is entered into the calculation, the score moves up or down depending on whether the data is good or bad. 

CarMax’s score is 2.10. Anything between 1.8 and 3.0 is considered in the Grey zone, which means it’s neither in the Distress zone nor the Safe zone above 3.0.

Considering its financials are so much better than Carvana’s, if you’re a call option buyer, I’d look to CarMax’s option chain for possible buys instead. If you’re a seller, Carvana’s call options look attractive at this point.

• Unusual Stock Options Volume Suggests Some Traders Are Prepping for a Recession
• Adobe Earnings: Iron Condor Could See 43% Return On Risk
• Unusual Activity in Amazon Put Options Show They Are Bullish on AMZN Stock
• Dave & Buster’s (PLAY) May Offer Upside for the Daring Contrarian